How Much of a 401(k) Should be Allocated to Annuities?
Participants (and pretty much everyone) love the idea of guaranteed income, just not necessarily when branded as an annuity.
But regardless of the product’s shortcomings, the Employee Benefit Research Institute (EBRI) has found that deferred income annuities can provide an effective hedge against outliving retirement savings.
“At current annuity rates, EBRI finds purchasing a DIA at age 65, deferring 20 years with no death benefits, results in an overall improvement in retirement readiness for all ages of death combined, when DIA purchases were up to 20 percent of the 401(k) balance,” Jack VanDerhei, Ph.D., Director of Research at the Employee Benefit Research Institute, said in a statement. “However, there is an overall decrease in retirement readiness for DIA purchases starting at 25 percent—due in part to the interaction with long-term care costs.”
The study finds an overall improvement in retirement readiness when DIA purchases equal to five, ten, and 15 percent of the 401(k) balance, and a pre-commencement death benefit is added to the DIA.
When the results are broken out by age at simulated death, there is an overall decrease in retirement readiness for those dying before benefits begin, as well as for those dying soon after benefits begin.
Investors living beyond age 89 will experience a significant increase in retirement readiness, with the larger the percentage of 401(k) balances being used to purchase a DIA, resulting in a larger percentage increase in retirement readiness.
EBRI’s study, Deferred Income Annuity Purchases: Optimal Levels for Retirement Income Adequacy, explores how the probability of a “successful” retirement, measured by the EBRI Retirement Readiness Rating (RRR), varies with the percentage of the 401(k) balance that is used to purchase a DIA.
Results are provided for all households with a 401(k) balance and analyzed by the simulated age of death.
With more than 20 years serving financial markets, John Sullivan is the former editor-in-chief of 401(k) Specialist and Investment Advisor magazine and retirement editor of ThinkAdvisor.com. Sullivan is also the former editor of Boomer Market Advisor and Bank Advisor magazines, and has a background in the insurance and investment industries in addition to his journalism roots. Experienced financial services content executive specializing in creative new media delivery. He joined the American Retirement Association in 2023 as Chief Content Officer, overseeing communications for the organization, as well as its sister organizations.
